Tax & Business Insights

Business Succession – Part I

Volume 14 Issue 6 --  November/December 2002

 This is the first in a series of three newsletters on “Small Business Succession” and bringing the younger generation into ownership.  Because the subject matter is so broad, it is impossible to cover the basic concepts in one issue.

To paraphrase General MacArthur, “Older business owners don’t die; they fade away.”  How to fade away, hopefully in good business fashion, while bringing in a younger generation, is not simple or easy.  Since there are so many ways to bring the next generation into the ownership-management of small businesses, we thought it would be interesting to discuss some of the methods.

Let’s assume that Nebuchadnezer, “NEB,” clearly the older generation, wants to bring his son, STUD, into the business.  In fact, NEB always anticipated bringing STUD into the business, which is why the stucco business owned by NEB was named Studco, Inc.

There are many ways NEB can transfer business interests and control in Studco to STUD (the younger generation) including:

  1. Make gifts of ownership interest;
  2. Sell stock to a younger generation;
  3. Create taxable stock bonuses (income to the recipient);
  4. Create a Sweetheart Deal (usually a stock redemption);
  5. Create a new competing business owned by the younger generation;
  6. Form an Employee Stock Ownership Plan; and
  7. Transfer interests at death through a Will or Trust.

These approaches are not mutually exclusive. In many situations, a well-designed plan will rely on several different techniques.


We have used the term “stock” to mean an “ownership interest,” whether it involves corporate stock, partnership interests, or membership interests in LLCs.  Think of Studco as being either a corporation, partnership, or LLC.  The interest may be voting or may be “non-voting” for a period of time or indefinitely. So, if NEB wants to bring STUD into Studco, he can give STUD stock but preclude STUD from voting or controlling the business until NEB’s death or some other time when NEB believes STUD has reached maturity.

Before looking at the specific approaches identified above, it is important to put this process into a broader context.  Business succession planning is not only about getting control of the business to a new generation of owners who want to continue the business.  It is also about the economics and tax consequences of doing this. Small business owners often have a substantial portion of their net worth tied up in their businesses, and being able to tap into that worth, without undue tax consequences, is often necessary or desirable for the happy retirement of the older generation owners.

The tax consequences that one must consider cut across the income tax as well as gift and estate taxes, along with the infamous generation skipping transfer tax.  Planning a tax-efficient succession has grown more complex as a result of the uncertainty Congress has created about the existence and impact of the estate tax after 2010, when, as the law stands now, the recently enacted provisions easing the burden of the estate tax, including total repeal for year 2010, would expire.

Gifts of Interest

In this issue, we will discuss the first method on the above list, which, perhaps, is one of the simplest ways for NEB to transfer ownership and control to STUD. NEB can make gifts of stock to his son.  The gifts could be staged over time or they could be made outright.  In general, under our current estate and gift tax law, it is often advisable to make gifts valued at $11,000 or less per donee per year to avoid using the lifetime exemption of NEB, currently $1,000,000. 

For example, if a gift of $50,000 worth of interest in Studco is given to STUD in one year by one parent (NEB), $11,000 (or $22,000 if NEB is married) would be excluded from gift and estate tax under the annual exclusion, while the remaining $39,000 would eat into NEB’s lifetime exemption for estate tax purposes.  Thus, NEB could incur higher estate taxes by making substantial gifts to STUD in one year. 

At the time of writing, the Bush administration is pushing for permanent repeal of the estate tax, but apparently not the gift tax, so check the current estate tax law.  Even without such a repeal, the lifetime exemption will increase between 2003 and 2009, when it will reach $3,500,000.

In our next issue, we will expand on some of the other above-mentioned ways for transferring business interests to a younger generation.

Copyright 2002
By Tax and Business Professionals, Inc.
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Manassas, VA 20110
(800) 553-6613

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